How to roll over your 401(k)

LAST REVIEWED Sep 15 2022 13 MIN READ

By The Human Interest Team

The U.S. Bureau of Labor Statistics found that 2.9% of Americans—that’s 4.3 million people—quit their jobs in August 2021, a record-breaking month preceded by similar statistic-shattering months that year. One year later, in August 2022, job creation was consistent, while a steady flow of people entering the workforce raised the unemployment rate.

If you're one of the millions of workers who have changed—or are considering changing—jobs in the last year or so, it's essential to take stock of your retirement savings. From understanding how vesting works to knowing the required steps of an indirect or direct rollover, this article reviews how to roll over a 401(k) account balance after leaving an employer.

What is a 401(k) rollover?

If you have funds in an existing 401(k), you must decide what to do with your plan when you start a new job or retire. A rollover occurs when you move all or some of your 401(k) savings into another eligible retirement account. To complete the rollover process, your current financial institution or plan transfers your account balance to another plan or IRA. 

Below are four steps that can help you explore the process of rolling over a 401(k) plan.

Step 1: Find out your fully vested account balance

When checking your 401(k) account balance, you may have never considered the amount you’d take with you if you were to quit or lose your job today. While your personal contributions (whether pre-tax or Roth) are always fully vested, your employer matching contributions and profit-sharing contributions may be subject to a vesting schedule

Take a look at the provisions of your 401(k) plan regarding employer contributions—as they may state that you earn these deposits over time. If you leave before earning a certain number of “vesting years of service”, you may not be entitled to receive 100% of the employer contributions in your account. 

Under a cliff vesting schedule, employer contributions only become vested after a minimum number of years. Under a graded vesting schedule, employer contributions are vested over time. Your quarterly benefit statement should provide you with an idea of your vested percentage, but be sure to verify your vesting with your employer before requesting a distribution.

When doing a cost-benefit analysis of accepting a new job offer, it may be prudent to review the cost of losing the unvested portion of your retirement account.

Step 2: Take stock of unpaid loans from your 401(k)

Here’s one reason why it may not always make sense to take a loan from your 401(k). If your plan has allowed you to take a loan, you’ll generally have up to five years to pay the loan back in full. If you terminate employment before the loan is fully repaid, the loan will become due in full upon termination. 

If you cannot pay back the remaining balance, that loan may turn into an early distribution, triggering income taxes, and if under age 59 1/2, a 10% penalty from the IRS. Some states may charge additional income taxes and penalties. You may be able to make a Qualified Plan Loan Offset (QPLO) contribution to an IRA. 

Please consult a tax professional for more information about QPLOs.

You can still roll over a loan offset from a 401(k) 

Although you can’t roll over an unpaid loan balance to another 401(k) or IRA and continue to make regular payments on it, you can avoid taxation on the loan offset that results when you take a distribution without repaying your outstanding loan balance. 

When your prior employer offsets the outstanding loan balance you owe, you will be required to take this outstanding amount as taxable income for the year. But, if you’re able to open an IRA (or if you have an existing IRA), you can indirectly rollover the amount of the loan offset to your account, by depositing the outstanding loan amount (plus any withholding) in cash to your IRA account as an indirect rollover. If you do this within the 60-day period following your loan offset, your outstanding loan amount will not be taxable to you at year-end. If you qualify for a QPLO, you’ll have a longer period of time to make a contribution to an IRA. 

To help avoid any issues, we think it’s best to pay off an outstanding loan before requesting a termination distribution if you can. If you do this, you can roll over the entire balance (including your former outstanding loan) to a 401(k) plan or IRA without involving the indirect rollover process.

Step 3: Avoid a “cash out”

Leaving the money in your old 401(k) can work against you

Even when you part ways with your employer on favorable terms—and are happy with your old 401(k) plan’s rules and fees—not rolling over your vested balance to a new account can work against you. First, you can no longer contribute to your former employer’s 401(k). And based on your vested balance, your previous employer may be able to force you to take a distribution from the account. 

  • If your vested balance is less than $1,000: Your employer could cash out your account and mail you a check—which could result in tax penalties.  

  • If your vested balance is between $1,000 and $5,000: Your former employer may transfer your balance to an IRA of its choice—which may not be the one you would choose.

More than half of 401(k) plans with balances between $1,000 and $5,000 are forcefully transferred to an IRA after separation from employment. According to a study conducted by the GAO in 2015, involving 19 forced-transfer contracts, forced-transfer IRAs can have typical investment returns ranging from 0.01% to 2.05% annually, which barely cover any IRA fees. 

Note: If you’re concerned about company securities, including stocks, bonds, or debentures that would be subject to income tax when withdrawn from your old 401(k), consult your plan administrator or financial advisor for tax scenarios that may help defer tax payment on the appreciation of those company securities.

You can still roll over cash outs from a 401(k)

If you do receive a cash out from your previous 401(k), it may be wise not to spend that check. For example, if you spend a $900 cash out instead of rolling it over into an account earning 8% tax-deferred earnings, your retirement fund could miss out on more than $8,000 in growth after 30 years*. The bigger your cash out, the higher your opportunity cost may be.

If you’re able to open an IRA that accepts the cash out check within 60 days from your last day of employment—consider taking advantage of an indirect rollover to recoup withholdings and avoid paying penalties.

You’ll have to deposit the cash out check as an indirect rollover. Any portion of the gross amount of the cash out that you do not roll into an IRA will be considered taxable income to you. Therefore, you should also deposit any federal and state withholdings originally taken from your cash out distribution and roll that into your IRA as well. If you do this within the 60-day period following your cash out distribution, the rollover amount will not be taxable to you and the withholding on the distribution will be used towards any taxes you owe to the IRS when you file your next tax return. If you do not owe taxes, the withholdings will be returned to you via a tax refund. 

To help avoid any issues, we think it’s smart to review your distribution options early after you terminate employment, and request a rollover distribution to a qualified plan or IRA of your choice before your employer forces you to take one.

*Using a compound interest calculator from Investor.gov, $900 growing at 8% over 30 years would equal $9,056.39. This calculation does not account for market conditions, distributions, administrative fees, or other miscellaneous costs. This is provided for informational purposes only and is not representative of an actual client’s experience and should not be viewed as such. An individual’s results will vary.

Step 4: Do a direct rollover to a 401(k) or IRA

This is often the most cost-effective way to perform a 401(k) rollover. A direct rollover empowers you to choose a retirement account that best suits your needs. If you choose to roll over your proceeds to your new 401(k) plan, check with your new plan administrator first, as some plans require eligibility terms to be met before you can deposit a rollover into your account. 

Oftentimes, physical checks for rollovers are still mailed via USPS, and providing incorrect payee information can cause delays in processing your rollover, leaving your funds uninvested longer than necessary. Here’s how to help avoid unnecessary delays in the rollover process”.

  • Check with your current 401(k) provider to see if they accept incoming rollovers. If they do accept rollovers, they should provide you with an incoming rollover form that will provide you with information about the process of rolling your funds into the 401(k) plan.

  • Notify your previous 401(k) provider that you’d like to roll over your funds to a new 401(k). Depending on your provider, this process may not be quick or cheap. For example, there may be a withdrawal fee (which Human Interest never charges!) and a form you need to complete before the plan can start the distribution process.

Each provider is different, but make sure to ask these questions, at the minimum, if the information is not provided on the incoming rollover or outgoing distribution forms:

  • Current provider: To whom should the check be made payable? What is the account number? What is the address to which the check should be mailed?

  • Previous provider: Is there a withdrawal fee? Will you be mailing me the check, or can you mail it directly to my new 401(k) provider (or their custodial bank) on my behalf? Will you send me a 1099-R form via email or mail? Is my contact information up-to-date in your system?

IRS Form 1099-R acts as a receipt to show that your money was rolled over and not withdrawn. Once you receive the form, you should file it when you do your taxes as proof that the money was rolled over, so that you won’t have to pay taxes on this transaction. Rollovers will be noted as a code G or H on the form, depending on the distribution source.

Start your 401(k) rollover with Human Interest today

Consolidating retirement savings in one plan may help you keep track of your retirement savings. That’s why it’s important to compare your available rollover options. Be patient with the rollover process. We believe you should focus on the retirement account that’s best suited for your long-term retirement saving plans and not on the one offering the least amount of paperwork.

As a reminder, if you are a current participant in a 401(k) plan administered by Human Interest, you won’t be responsible for any future transaction fees. Interested? Contact us today to start your 401(k) rollover. We’re here to provide you with the resources to help you save the way you deserve.

We believe that everyone deserves access to a secure financial future, which is why we make it easy to provide a 401(k) to your employees. Human Interest offers a low-cost 401(k) with automated administration, built-in investment education, and integration with leading payroll providers.

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Notes

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*Using a compound interest calculator, $900 growing at 8% over 30 years would equal $9,056.39 (note: this calculation does not account for administrative fees or other costs).